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Few Will Receive Restitution Under SEC Settlement Decision

By Jerry Knight

Monday, February 14, 2005; Page E01

Thanks to stock market regulators, Washington investors who lost money on the stocks of WorldCom Corp., XO Communications Inc., CAIS Internet Inc. or United Therapeutics Corp. may finally get some of their money back.

But don't count on it.

Reporters pick up information about a settlement the Securities and Exchange Commission announced at a 2003 news conference. Some people who bought any of 50 stocks could be eligible to receive settlement money.
(Stefan Zaklin -- Getty Images)

Most investors are being frozen out of a $433 million pool set up to compensate investors who suffered losses on 50 stocks, including the four locals, that were touted by dishonest Wall Street securities analysts.

The pool was announced as a "historic settlement" in April 2003 when the Securities and Exchange Commission and four other regulators brought conflict of interest cases against a dozen of the biggest investment firms on Wall Street. The cases exposed one of Wall Street's dirty little secrets: Brokerage firms routinely recommended stocks of companies that were their investment banking clients even though they had doubts about whether those stocks were good investments.

The Wall Street firms agreed to stop the practice and to pay hundreds of millions in penalties to compensate customers who were misled into making bad investments. Now details of how that money will be distributed to investors have been disclosed by the federal court in New York that is handling the cases. They show what many critics suspected at the time of the settlement -- that the restitution pool is such a tiny fraction of what investors lost that most investors won't get a dime.

It's not just that there isn't enough money to go around; the catch is a little-noticed decision by the SEC that severely restricts who is eligible to recover losses.

The SEC has decreed that refunds will be given only to investors who bought stocks directly from the brokerage firms cited in the cases and only if the shares were bought at specific times, usually right after the brokerage houses issued research reports recommending those stocks.

If you bought the very same stock at the very same time from another firm, you're out of luck.

Investors in a few of the 50 tarnished stocks are likely to get back every penny they lost, says Francis E. McGovern, the Duke University law professor appointed by the federal courts to oversee the restitution pool, known as the Global Research Analyst Settlement Distribution Fund.

A specialist in resolving big disputes, McGovern has access to the trading records of the firms involved in the case and has a pretty good handle on where the money will go.

In the case of a few of the stocks -- McGovern won't name them -- there were relatively few victims and there's enough money to go around. It's not yet possible to calculate what the payback will be on the other stocks, but it is clear that lots of people will get nothing because of the SEC decision.

Take CAIS Internet, a defunct Washington firm that wired office buildings and hotels for Web connections. If you bought CAIS stock from Bear, Stearns & Co. from Nov. 7, 2000, to April 24, 2001, you stand to get some money back.

Bear, Stearns, however, doesn't have many customers, or even a retail branch, in the Washington area. The New York firm managed the initial public offering of CAIS in 1999 and subsequently issued research reports recommending CAIS stock.

Washington investors who heard that Bear, Stearns was recommending CAIS stock but who bought the shares through a different broker are not eligible to collect. Those investors do have the option of suing, though, and many class-action lawsuits have been filed on behalf of investors.

CAIS went public in May 1999, selling stock for $19 a share. The stock did well at first and CAIS attracted investments from such big-name firms as Microsoft Corp., Cisco Systems Inc. and Kohlberg Kravis Roberts and Co., the big buyout firm.

But Internet communications evolved so rapidly that within two years after going public, CAIS was in trouble. It began selling off some of its operations, changed its name to Ardent Communications Inc. and finally filed for Chapter 11 bankruptcy protection in October 2001 -- just 29 months after going public. A little more than a year later, the last of its operations were sold. The stock wound up being worthless.

Shares of XO Communications and WorldCom also became worthless after those companies went through reorganizations in bankruptcy. XO is now chaired by financier Carl Icahn, who is also a major shareholder. WorldCom changed its name to MCI when it came out of bankruptcy, but the MCI stock that trades now is not the same as the original WorldCom shares. United Therapeutics, the fourth local firm named in the cases, survived to become one of the region's most successful biotechnology firms.

As with CAIS, only investors who bought from specific firms at specific times are eligible for restitution:

McGovern, a specialist in settling big disputes, said it wasn't his idea to limit the loss pool to customers of the firms involved in the cases.

"This issue of who qualifies, who is eligible to be a recipient of the funds, was resolved prior to my involvement. It was one of the parameters that was set in advance," he said. "There was no flexibility."

The SEC made the decision, but agency officials declined to discuss it, saying their reasoning is spelled out in court filings in the case.

Basically, SEC lawyers argued in court documents that there was no better way to identify and indemnify the victims of dishonest stock analysts, especially when there were so many victims and so little money to cover their loses. "The Commission recognizes that it is possible that not everyone who was conceivably affected by the defendants' conduct would receive payment," the SEC lawyers noted. "In light of the limited funds available," they said, "this exclusion is appropriate."

It's straightforward to say that investors who bought stock from a firm that was issuing misleading research reports were harmed, the government lawyers explained. "Any injury suffered by an investor who did not purchase through one of the defendants is more remote and speculative.''

That argument is pretty hard to swallow in this age of information.

Analysts hyping their investment banking clients' stocks were all over television and the Internet. They weren't just blowing smoke at their own customers, they were clouding the ether with puffery, inflating the tech stock bubble with their hot air.

Investors' expectations were also inflated by the way the analysts' settlement was hyped by the SEC and the four other regulators who joined in the case -- the New York Stock Exchange, the North American Securities Administrators Association (the organization of state regulators), the National Association of Securities Dealers and the New York attorney general.

It was clear at the time that the "historic" penalties were a pittance compared with how much investors lost on the 50 stocks identified in the case and how much the Wall Street firms made from their misleading recommendations.

Investors who had held out hope of getting some of their money back now need to accept that it's probably not going to happen. People who do qualify for a piece of the settlement will be notified in a few months and should get their checks next year.